Indostar Capital Finance is a Mumbai-based non-banking finance company providing structured term financing solutions to companies and loans to small and medium enterprise (SME) borrowers. The portfolio was recently expanded to offer vehicle finance and housing finance products.

Promoted by Indostar Capital, part of the Everstone Group, an India and Southeast Asia-focused investor recognized as the Private Equity Firm of the Year in India by Private Equity International for six consecutive years till the calendar year (CY) 2016, has approximately US$ 4.0 billion of assets under management. Strong capital sponsorship and professional expertise of the promoter has enabled implementing international corporate governance standards.

R. Sridhar, a whole-time director designated as the executive vice-chairman and chief executive officer, is associated as director since 18 April 2017 and has three decades of experience in the financial services industry including being managing director of Shriram Transport Finance Company.

There are four businesses: corporate lending, SME lending, vehicle financing and housing financing.

Corporate lending consists of lending to mid-to-large sized corporates in manufacturing, services and infrastructure industries and to real estate developers against tangible collateral as well as security in other forms such as charge on operating cash flows. The corporate lending business accounted for 76.8%, or Rs 3969.34 crore, of the total credit exposure end December 2017 compared with 99.8% end March 2015.

SME lending commenced in CY 2015 and involves extending secured loans for business purposes to SMEs in 10 major cities across eight states, secured against self-occupied residential and commercial property. The SME lending business accounted for 22.7% or Rs 1173.34 crore of the total credit exposure end December 2017.

The vehicle finance business, commencing in November 2017, lends for purchase of used or new commercial vehicles, passenger vehicles and two-wheelers. Vehicle finance credit exposure stood at Rs 14.30 crore end December 2017.

Housing finance comprises two business lines of affordable housing finance that commenced in September 2017, and retail housing finance that started in March 2018 and operates through wholly owned subsidiary IndoStar Home Finance. The housing finance credit exposure stood at Rs 14.59 crore end December 2017.

The corporate lending business operated from the registered and corporate office, while retail operations spanned to 71 branches across India end February 2018. To grow the retail operations, the 100th branch was opened in Vadodara, Gujarat, on 6 April 2018. The distribution network includes 548 personnel in in-house sales team and 949 third-party direct sales associates (DSAs) and other third-party intermediaries.

The total revenues recorded CAGR of 31% to Rs 719.92 crore in the fiscal ended March 2017 (FY2017) from Rs 241.58 crore in FY2013. Profit after tax (Pat) registered a CAGR of 24% to Rs 210.8 crore between FY2017 and FY2013.

The loan book nearly trebled in four years from Rs 1833 crore end March 2013 to Rs 5234 crore end March 2017. The cumulative loans disbursed since the commencement of operations amounted to Rs 22592.98 crore end December 2017, out of which Rs 17418.54 crore had been repaid. However, the loan book narrowed to Rs 5178 crore end December 2017 on account of 13% decline in the corporate loan book in the nine months of FY2018.

The gross NPA ratio stood at 1.7% and the net NPA at 1.3% end December 2017. There is clear segregation between sourcing and credit approval teams so as to ensure independence and effectively manage operational risks.

Long-term relationships were maintained with 14 public sector banks, 13 private sector banks, 21 mutual funds and four insurance companies and other financial institutions end December 2017. The average cost of borrowings has been consistently moderating from 11.9% in FY 2015 to 9.1% in nine months of FY2018. The capital adequacy ratio is strong at 31.6%. The low leverage levels and high capital adequacy give significant headroom to grow business.

The Offer and the Objects

The initial public offer (IPO) is to collect around Rs 1840 crore by issuing 3.228 crore shares at the lower band of Rs 570 per share (face value Rs 10 per share) and Rs 1844 crore by issuing 3.224 crore shares at the upper band of Rs 572 per share. The issue consists of a fresh issue of equity shares (1.224 - 1.228-crore shares) aggregating up to Rs 700 crore and offer for sale (OFS) of two crore equity shares aggregating up to Rs 1140-1144 crore.

The OFS comprises an offer aggregating 1.85 crore shares by promoter Indostar Capital and 0.15 crore share by other selling shareholders. The issue is to be made through the book-building process and will open on 09 May 2018 and will close on 11 May 2018.

The net proceeds from the fresh issue will go to augmenting the capital base to meet future capital requirements. Further, there will be the benefits of listing of the equity shares on the stock exchanges, enhancement of the brand name and creation of a public market for equity shares in India.

Total credit exposure recorded a CAGR of 30%, revenue 31% and Pat 24% between FY2013 to FY2017, underpinned by the strong net interest margins that improved from 6% in FY2015 to 6.9% in the nine months of FY2018. Returns on average assets stood at 3.8%, returns on average equity at 10.9%, the debt-to-equity ratio at 1.78x and capital adequacy ratio at 31.6% in the nine months of FY2018.

Corporate lending, which accounts for 76.8% of the total lending, is considered as relatively risky and low-growth segment compared with retail loans.

Recently expanded into vehicle and housing finance. These businesses need to be run successfully.

The growth rate slowed down in the last two years. Credit exposure was up only 23%, revenues 12% and Pat 10% in FY 2017. The growth rates in revenues slowed down to 9% and Pat 4% if the nine-month of FY 2018 figures are annualized.

Gross NPAs jumped from 0.2% in FY 2016 to 1.4% in FY 2017 and further to 1.7% end December 2017.

The exposure to the real estate sector accounts for 41.6% of the total lending, followed by financial services at 10.8%, poultry products 6.9%, digital cable 3.5% and energy 2.3%. Most of these are considered high-risk segments.

The corporate lending business, particularly the real estate loan portfolio, is significantly dependent on operations in the Mumbai Metropolitan Region and comprised 93.9% of the real estate loans disbursed end December 2017.

Third-party service providers are engaged for certain parts of operations including the valuation of assets and legal services, DSAs and other third-party intermediaries. The agreements with them do not provide for any exclusivity. They can work with other lenders, including competitors.

Nearly 11.2% end December 2017 and 17.2% end March 2017 of the total credit exposure was unsecured.

A legal notice has been received from one shareholder, Sanjay Hinduja, alleging illegal forfeiture of certain partly paid-up incentive equity shares held by him in non-compliance with the IndoStar Agreement. Estimates of the loss suffered by Hinduja are at least Rs 100 crore. A response was sent on 7 April 2018, denying all the allegations and averments made in the notice. Initiating of legal proceedings by the shareholder against the company. promoter, directors and/or ??KMPs can adversely affect business, reputation and prospects.

Valuation

The annualized EPS on post-issue equity works out to Rs 24.0 for the nine months of FY2018 and Rs 23.1 for FY2017. At the price band of Rs 570 to Rs 572, P/E works out 23.7 to 23.8 times for nine months of FY2018 and 24.6 to 24.7 times for FY2017.

Post-issue, the book value (BV) works out to Rs 304.6 at the issue price of 570 and Rs 304.7 at the issue price of Rs 572. P/BV will be 1.88 times. Post-issue adjusted BV (net of net NPAs) is Rs 296.9 per share and P/Adj BV 1.93 times.

Among peers, Shriram City Union Finance is trading at P/BV of 2.9 times and Capital First at P/BV of 2.5 times.